The Investment Climate for Informal Firms

Transcription

1 The Investment Climate for In Firms Mary Hallward-Driemeier and Andrew Stone * DECRG and ICICS September 24 Abstract: This paper draws on the results of new surveys in 11 developing countries to compare how the investment climate varies across in firms. Extensions to the World Bank s Investment Climate Surveys to include 325 micro and in enterprises provide new insights into both the perceptions of local entrepreneurs about constraints they face, but also objective measures of the quality of infrastructure, regulatory burdens, crime, access to finance, and the security of property rights. The paper examines how memberships in associations can help address some of the costs, risks and barriers to competition facing in firms. With smaller firms facing costs that are up to a third higher than larger, firms, improving investment climate conditions will disproportionately benefit the smallest firms. * The views expressed are those of the authors and do not necessarily reflect official views of the World Bank.

2 In making production, investment and employment decisions, entrepreneurs care about the security of their property rights, the potential costs imposed by regulations, the extent of corruption, and the quality of infrastructure. These are all part of the investment climate, the conditions that shape the incentives and opportunities facing firms. And all are influenced by the quality of government policies and behaviors. While the importance of improving the investment climate is increasingly recognized, to date it has been difficult to measure many aspects in a consistent and comparable manner. 1 The World Bank has contributed to the effort to collect and make available better data on the investment climate through Investment Climate Surveys. The World Development Report 25 extended these surveys to include micro and in firms in 11 developing countries. The Investment Climate Surveys give firm-level experiences with specific regulatory burdens, sources of finance, the quality and access to infrastructure services, security of property rights and corruption. The surveys also provide measures of firm performance, allowing for the impact of investment climate conditions on investment rates, growth and employment to be assessed. The countries surveyed are Bangladesh, Brazil, Cambodia, Guatemala, India, Indonesia, Kenya, Pakistan, Senegal, Tanzania and Uganda. The paper begins by looking at the rankings of constraints as reported by firms. How these vary by the size of firm and whether it is ly registered are two dimensions of particular interest. In addition, distinctions are made between urban and rural in firms. The variations in the investment climate demonstrate the scope for improvement, and that the firms that would benefit the most are the smallest enterprises. The scope for membership in business and other associations is examined as a way of mitigating some of the costs, risks and barriers to competition facing smaller and in firms. Top investment climate constraints as reported by firms The surveys ask for both perception data and more objective information. The perception data provides insights into what entrepreneurs see as their most pressing constraints and provides one way to compare potential areas for reform. With investment decisions ultimately resting on perceptions of the future, having such indicators are certainly useful. In the Investment Climate Surveys, firms are asked to rank up to 18 potential issues on the degree to which they represent an obstacle to the growth and operation of the business. Answers range from no obstacle, to minor, moderate, major to very severe. Figure 1 reports the findings, pooling together all the firm surveys. It is striking that the number one concern of firms is policy uncertainty. Firms are unsure not just of what new laws governments may pass in the future, but also about how existing ones may be applied. 1 Burgess and Venables (23). 2

3 Figure 1. Policy uncertainty ranks as the top obstacle facing firms in developing countries Formal Inf ormal Cost & access to finance Electricity Tax rate Regulatory uncertainty Macro instability Corruption Access to land Reg and tax admin Transportation Crime Skills Telecommunications Courts Labor regulations Share of firms responding constraint is major or severe Source: World Bank Investment Climate Surveys Almost 95% of firms see regulations interpretations as being unpredictable at least some of the time, making their property rights less secure. Also, half of firms report that they are not confident that the court would uphold the property rights they do have. As a result, many firms do not rely on written contracts, conduct business only with people they know and incur costs when suppliers deliver goods late or that are below agreed upon quality. Late payments can be a problem and with few mechanisms seen as available or reliable, collecting such payments is a problem reported by many firms. Labor contracts too are often in. While workers can suffer from less job security and benefits, many employers also report that absenteeism can be a significant concern. Corruption also ranks highly as a constraint. This too can have both a risk and a cost component. To the extent there is uncertainty that bribes will be required or what size they might be, there is a risk. But in many situations, irregular payments are the norm, with amounts well known and expected. They are treated as a necessary cost of getting business done. Bribes are reported as paid by the majority of firms. Likely under-reported, there is no denying this is a widespread feature in developing countries. The size of bribes varies, up to 6 percent of sales in Peru, Azerbaijan, Algeria and Cambodia. The numbers are higher for in firms, reflecting in part that fixed sums are larger for in firms and due to harassment from officials. Table 1 Bribes vary by firm size, sector and region 3

4 Firms reporting bribes Bribes paid as share of sales FORMAL Micro (<1) Small (1-19) Medium (2-49) Large (5-249) Very large (25 +) INFORMAL Small (<1) Large (1+) East Asia Eastern Europe CIS Latin America South Asia Sub-Saharan Africa Figure 2 also shows how gaps between policies and how they are implemented and greater uncertainty of property rights are associated with higher bribes in most regions. Figure 2. Unpredictability of policy implementation and uncertainty of property rights are associated with higher bribes in most regions. Relative increase in share of income paid in bribes Firms that find the interpretation of regulations unpredictable pay more bribes 5% 4% 3% 2% 1% % SubSaharan Africa East Asia & Pacific East Europe Central Asia Latin America & Carribean South Asia Relative Increase in share of income paid in bribes Firms that do not trust courts to uphold property rights pay more bribes 8% 6% 4% 2% % SubSaharan Africa East Asia and Pacific East Europe and Central Asia Latin America and Carribean South Asia Source: World Bank Investment Climate Surveys Infrastructure disruptions are another source of costs. Chief among them are electrical outages. The overwhelming majority of firms report being affected by them, many multiple times a week. Firms are asked how such outages affect production. In India, Eritrea, Uganda and Kenya these losses can add up to over 1 percent (figure 5). 4

5 While in countries like Poland it is around.6% of sales. Delays in transportation, breakage and theft are another concern of firms. Such delays make it harder to plan production, and can result in lost sales particularly to larger or multinational firms that are more sensitive to delivery schedules. Crime is a cost that also adds up for many firms. There are costs of providing security. Many entrepreneurs also report paying for private security payments or protection money too keep local gangs at bay. And there are losses from theft and vandalism itself. In Guatemala, over 4 percent of firms report crime as a problem, with costs approaching 5 percent of sales. In Armenia, the costs of crime are almost 15 percent of sales (figure 6). Tax rates rank quite highly in some regions. A perennial source of complaint, what is striking is that it ranks higher in countries where public services are low and inity is high. One of the sources of complaint about paying taxes is that many firms know that local competitors in the in sector are not subject to them, putting them at a cost advantage. The less compliance on tax payments, the more likely it is that those that pay will complain. The correlation with the share of firms complaining about tax rates and actual tax rates is positive, but only weak. Higher tax rates can encourage more firms to remain in, keeping the tax base small and in competition high. But what is also true, is that as much as firms may complain about taxes, there are other investment climate costs that outweigh them. [ADD analysis about how memberships in business associations or ties with NGOs help in firms to cope with the costs and risks they face.] Differences across different types of firms Large and small firms. The quality of the investment climate varies by size of firm. Smaller firms often face higher costs and report slightly higher unease about property rights and unpredictable regulations. Some of the costs represent fixed costs which, proportionately, are higher for smaller firms. This can be true of license or permit fees or even of bribes. Evidence from the surveys indicates that bribe payments are 5 percent larger as a share of sales for small firms. Large firms may make higher payments, but the burden they represent may be smaller. Adding up various costs associated with a weak investment climate illustrates that the overall burdens are larger for smaller firms (controlling for age, sector and country). Thus small firm s can face costs up to one third larger than very large firms (figure 3). 5

6 Figure 3. Costs of a poor investment climate are higher for small firms 25 Infrastructure Bribes Contract Enforcement Crime Regulation 2 Costs as percent of sales In Small, <2 Medium, 2-49 Large, Very large, 25 on up Note: Controlling for firm age, sector and country. Source: World Bank Investment Climate Surveys Smaller firms also tend to have greater difficulties getting finance than larger firms and to pay higher interest rates survey data show that small firms are 5 percent more likely to see this as a major or severe constraint. Larger firms are more likely to have a bank loan, reflecting the advantages of having a track record and holding more assets that can be pledged as collateral (figure 4). Smaller firms tend to complain more about corruption, but find regulations particularly labor regulations less constraining. It is possible that they are not fully compliant with regulations, making them targets for demands for in payments from officials. Small firms also report greater harassment and uncertainty due to unpredictable interpretations of regulations by officials and have less confidence that the judicial system will uphold their property rights. 6

7 Figure 4. Constraints vary by firm size and status Share of firms with a loan Small firms have less access to loans in small medium large very large Share of sales lost due to outages Smaller firms suffer more from electicity outages in small medium large very large Share of firms Small firms find government services less efficient in small medium large very large Share of firms worried by officials' discretion Smaller Firms see regulations as less predictable in small medium large very large Source: World Bank Investment Climate Surveys and WDR Surveys of Micro and In firms in 11 countries. Smaller firms also have less access to alternatives. For example, if electricity is unreliable, private generation is possible. However, generators are expensive and larger firms benefit from economies of scale. The same is true for dealing with property crime. Providing security can be relatively cheaper for large firms. Larger firms often have deeper pockets with greater access to finance making certain alternatives feasible and make the smoothing of shocks more feasible. A significant implication is that improving the basic elements of the investment climate will disproportionately help small firms. 7

8 Figure 5. Management time spent with officials can be extensive Inspections Percent of management time spent dealing w ith government officials Micro (1-1) Small (1-2) Medium (2-5) Large (5-25) Very large (25 & up) Source: World Bank Investment Climate Surveys Formal and in firms. Inity is one of the defining features of the landscape in most developing countries. While measurement difficulties abound, it has been estimated that in activities account for 76 percent of GDP in Nigeria, 55 percent in Guatemala, and 5 percent in the Philippines. 2 The investment climate for in firms can differ markedly from that for firms in the economy. Operating free from taxes and regulatory requirements reduces some burdens. But just as small firms face greater constraints than larger firms, the constraints can be even greater for small in firms. In firms often have more difficulty getting public services and finance at reasonable costs. For example, in Peru the nominal borrowing rate for in firms was found to be more than four times the rate for firms of a similar size. 3 Figure 6 illustrates how much in firms have to rely on internal finance and in sources of finance. Inity is also a source of added risk. Noncompliance with taxes and regulations leaves in firms vulnerable to being evicted or shut down, and makes them easy targets for bribes or bureaucratic harassment from officials. Again, the sums can be small, but relative to sales they can affect the viability of the enterprise. 4 2 Schneider (22). 3 de Soto (2). 4 For additional details on the results of the -in comparisons, please see Hallward-Driemeier and Stone (24). 8

9 Figure 6. In firms have less access to external finance Formal Firms In Firms State sources 3% Family and friends 7% Equity 9% Other 11% Internal funds 53% State sources % Family and friends 13% Banks 4% Other 11% Internal funds 72% Banks 17% Source: World Bank Investment Climate Surveys and WDR Surveys of Micro and In Firms in 11 countries. Rural and urban firms. Firms operating in rural areas often face very different investment climates than their urban counterparts. Distance and lower population densities increase the costs of providing infrastructure and other public services in rural areas. One response is for rural firms to choose business opportunities that are less reliant on higher quality infrastructure services. Thus, for some, infrastructure may not rank as highly as an obstacle reflecting choices that make it a less significant component of their operations. Access to finance can be more of a constraint. Small market size can also reduce growth opportunities for rural firms, which thus face constraints similar to small firms generally. There also tends to be a high incidence of inity in rural areas, with similar costs and risks. On the other hand, in firms in urban areas can suffer from increased costs of crime and more red-tap and harassment from officials (figure 7). Figure 7. Obstacles for in firms in urban and rural areas While some constraints are the same... urban rural 1...some constraints differ Percent of firms reporting Percent of sales (percent) urban rural Lack confidence in courts Unpredictable interpretations of regulations Goverment services inefficient Losses from power outages Losses from crime Management time spent with officials Note: Controlling for size of firm, sector and country. Source: World Bank Investment Climate Surveys and WDR Surveys of Micro and In Firms. 9

10 [ADD: Rural firms face higher challenges linking with larger firms. They are more likely to sell directly to consumers. The role of distribution networks, time to markets etc. will be examined.] Links to performance: These measures of the investment climate can be linked to firm performance. Using regression analysis to control for various firm characteristics, coefficients from the included investment climate indicators can be used for a number of thought experiments. Comparing states in India that have a strong investment climate with those with a weak investment climate explains 4% of the productivity gap. Within China, if Tianjin could achieve the same investment climate conditions as Shanghai s, firm level productivity could increase by 15 percent and sales growth could increase by 2 percent. 5 More broadly, if countries could achieve the same investment climate conditions as the best performing location in developing countries, firms in Dhaka could reduce 4 percent of their productivity gap, those in Calcutta 8 percent. Wages could rise by 18 percent and 38 percent respectively in those cities. The impacts are large, and the benefits are shared between firms and workers. 6 [The above work reflects comparisons of firms. This section would use a similar methodology to compare both the in sector across countries and with their counterparts.] References Acemoglu, Daron, and Simon Johnson. 23. "Unbundling Institutions." National Bureau of Economic Research Working Paper Series Cambridge, MA. Acemoglu, Daron, Simon Johnson, and James Robinson. 21a. "The Colonial Origins of Comparative Development: An Empirical Investigation." American Economic Review 91(5): "Reversal of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution." Quarterly Journal of Economics 117: Barro, Robert The Determinants of Economic Growth. Cambridge, MA: MIT Press. Burgess, Robin, and Tony Venables. 23. "Towards a Microeconomics of Growth." London School of Economics: London. Processed. 5 Hallward-Driemeier, Xu, and Wallsten (23) 6 Dollar, Hallward-Driemeier, and Mengistae (23) 1

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